We hope you don’t mind the extra helping of CalPERS articles today. Although they are both about CalPERS’ private equity “new business model,” you’ll see that this piece looks at it from a much broader vantage than JJ Jelincic’s article. His piece, which I hope you’ll also read if you haven’t yet, makes detailed observations about staff’s efforts to justify the scheme. The New York Magazine article, by contrast, take a big picture perspective. It also made Google Alerts for “CalPERS,” so it should be giving CalPERS staff some well-deserved heartburn.
If you are so inclined, please comment at New York Magazine as well as here. I know some of you had problems when your tried commenting on earlier articles. I alerted my editor and he said the tech team was working on it, so we hope they’ve fixed the glitches. Thanks!
The $340 billion California Public Employees’ Retirement System, or CalPERS, has been laboring mightily recently to launch a “new private equity business model” — four new initiatives ostensibly designed to improve on the fund’s return — just as private equity reporters, in a departure from their usual form, have taken to ridiculing the nation’s biggest and once highly-esteemed public pension fund. Sam Sutton and Chris Witkowsky of PE Hub burst out laughing on a 2017 podcast. Dan Primack of Axios compared CalPERS’ private equity machinations to how “a toddler treats a Netflix queue.” The Wall Street Journal even trolled CalPERS over its ostensible trouble with understanding investment fees and presented the giant fund as in need of gee-whiz algos to do its basic bean counting.
But these reporters may have been missing the real story. Even months after presenting a supposedly final version of its new model, which has since been revised considerably, the giant fund has yet to offer a coherent justification of why it is making radical changes, particularly since most of the elements of this new scheme would further enrich already egregiously well-compensated private equity industry professionals. Giving more to investment middlemen is inconsistent with the principles of improving returns and with CalPERS’ long-standing efforts to minimize investment costs. Even the normally deferential Pensions & Investments devoted much of a lengthy story published last month to puzzling over the contradictions and inconsistencies of the plan.
In other words, this plan is so criminally incompetent that insiders are wondering about actual criminality. Former board member J.J. Jelincic, who was present at the private equity initiative’s inception, says:
In all my years of working with the system, I’ve never seen anything that makes my hair stand up on the back of my neck like this. Even though I can’t point to anything specific, my gut says someone will go to jail if this gets done. And my gut has a good track record.
The original plan, which was announced with great fanfare in May, was based around four “pillar” initiatives. One was to turn most and perhaps all of CalPERS current investment over to a “fund of funds” manager. The second was to commit more money to “emerging managers,” as in younger and smaller funds, even though this is the worst-performing of CalPERS’ current strategies. The third and fourth pillars had the same structure but different strategies. As originally described, CalPERS would commit roughly $5 billion each to two newly created private equity firms that would have CalPERS as their only client. Each would pursue a fad: “late-stage venture capital” and “Warren Buffett investing,” meaning ownership of investee companies for longer than the usual four to five years and a focus on the “core economy,” whatever that means.
If you don’t know the private equity industry, you are unlikely to detect defects that are obvious to incumbents. This plan would send CalPERS in the opposite direction of its peers in their own attempts to improve private equity returns, which involve building up their skills and bringing more of their private equity investing in-house to cut fees and reduce costs. CalPERS has estimated its annual private equity fees and costs at a mind-boggling 7 percent per year. Cutting that to 2 or 3 percent by relying on CalPERS’ own staff would add directly to returns. CalPERS can pay new hires market rates as long as it can substantiate the compensation level. Canadian pension funds are already well down this path and some American pension funds are following them.
But CalPERS is perversely determined to launch a “new business model” which has no realistic prospect of bettering returns, and worse, three of its four initiatives would almost certainly increase its costs. For instance, the two newly created funds would have CalPERS paying for start-up expenses on top of everything else, when first-time managers underperform established players. And two $5 billion commitments would reduce CalPERS’ diversification, another negative for expected returns.
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Why should shenanigans in provincial Sacramento matter? CalPERS’ conduct provides a peek into the tight, seldom-examined interrelationships between state and local government pension systems and private equity fund managers. And that includes more unsavory activity than the public is aware of, including criminal conduct. A former CalPERS CEO is now in federal prison serving a four-and-a-half-year sentence for bribery and fraud, and a former board member killed himself before his prosecution began. And CalPERS is far from alone. Alan Hevesi, the former comptroller of New York State and sole trustee for the state’s pension fund, went to jail, in part, for accepting bribes from a private equity firm. The former treasurer of Connecticut, Paul Silvester, landed in prison thanks to a bribery scandal involving a D.C.-based private equity firm, Carlyle.
The story continues here. Thanks again!